Does preferential trade benefit poor countries? A general equilibrium assessment with nonhomothetic preferences

We study the effects of preferential trade agreements (PTA) in a model where income matters for consumption patterns. We develop a three-country Ricardian trade model in which goods are ranked according to priority and where economies differ in their income level. The poorest (richest) country has a comparative advantage in the production of lowest-ranked (highest-ranked) goods, specializing in goods with low (high) income elasticities in demand. The medium rich country specializes in the production of the intermediate-ranked commodities. We find that being a nonmember of PTA leads to a terms of trade deterioration for a poor country, and a terms of trade improvement for the high-income country. Becoming a member of a PTA also does not guarantee welfare gains for the low income country, unless it is so poor that it cannot import the higher-ranked goods that the rich country produces